Run down of Northern Rock's Granite mortgage arm could cost taxpayer £3billion

21 November 2008 / by None

Northern Rock has decided to run down its off-balance sheet mortgage arm, Granite, but it could cost the taxpayer an additional £3billion, on top of the billions of pounds Northern Rock has already cost.

Granite is Northern Rock's Gurnsey-based funding vehicle, which it has used to raise billions of pounds on international capital markets using its mortgage book as collateral. Its £35billion of assets started to be run off yesterday, which goes against the agreed terms of Northern Rock's nationalisation but has been allowed to happen because the Treasury believes it to be in the best interest of the taxpayer.

Taxpayers could face a loss of £3billion if insufficient funds are available to repay all of Granite's investors, but if there are surplus funds then they will benefit Northern Rock's nominated charity, Down's Syndrome North East.

Granite could only remain operational for as long as Northern Rock continued to feed it more home loans, but, as a Northern Rock spokesperson explained to the Guardian, the nationalised bank is now moving towards a more conventional funding model which relies more on savings deposits than securitisation.

Since Northern Rock triggered the run-off yesterday by stopping the flow of mortgages to its off-shore company, Granite has seized £3billion of taxpayers' money, which will not be returned until Granite's bondholders have been repaid, which one banker has estimated will not happen until 2015.

When Northern Rock was nationalised, the Government was adamant that Granite would not also become the responsibility of the taxpayer, but it is now becoming clear that the taxpayer is exposed to losses from the off-shore mortgage vehicle.

How much of the money is recovered will depend on the quality of Granite's mortgage book, which is rapidly deteriorating, with the bondholders who hold the highest-rating bonds at the top of the priority list, and the taxpayer at the bottom.

In its Quarter 3 trading statement, Northern Rock chairman Ron Sandler said that he is "pleased with the progress Northern Rock is making. We have continued to repay the Government loan well ahead of plan, our deposit base is growing, our restructuring programme has been completed successfully, and a new and stronger management team is now in place."

However, he also said that while "These are encouraging developments," the "dislocated financial markets and falling house prices mean that the pace of progress achieved to date will be significantly more challenging to maintain going forward."